Bull market in "sixth inning"

(3:41)

Barron's Top 100 Advisor Shelley Bergman is still upbeat on U.S. stocks, but he also sees opportunities in muni bonds, preferred shares, and emerging markets.

Closed-end funds are regulated mutual funds which you buy on the stock market. Unlike other funds, they issue a fixed number of shares which then trade like stocks. That means the share price can sometimes fluctuate wildly above or below the underlying value of the fund—meaning investors can sometimes buy $1 worth of assets for 95 cents or less.

Today a number of high-quality funds are trading at 90 cents on the dollar or less.

Gondor says the funds began selling off in late May, when Federal Reserve chairman Ben Bernanke spooked bond investors by warning that the Fed would soon begin winding down, or “tapering,” its support for the bond market.

Bond prices fell on the news. Closed-end bond funds fell even further, because many of them are leveraged, meaning that they borrow some money to buy extra investments. And the shares of closed-ends fell further still because the market for closed-end funds is dominated by retail investors, who are often prone to panic in a selloff.

A year ago many of these funds were so fashionable that investors were willing to pay $1.10 or more for each dollar of assets—a crazy bet.

Today, they’re on sale.

“As much as investors loved bond funds a year ago,” says Gondor, “now they don’t want to touch them with a 10-foot pole.”

Gondor notes the average closed-end fund investing in taxable bonds now trades at a 7.5% discount to net assets (in other words, you’re paying 92.5 cents per dollar of assets in the fund), and the funds that invest in tax-free municipals trade at an average 7.7% discount.

She names five funds that the Herzfeld firm particularly likes.

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Two are regular, taxable-bond funds. The first is Putnam High Income Securities
PCF, -0.37%
, which invests in corporate debt rated below investment grade. This includes a lot of convertible bonds and some “preferred stocks,” which are effectively perpetual bonds. Most of the bonds are rated a semi-respectable BBB or BB, and most mature within five to nine years, so the interest-rate and inflation risk isn’t too bad. The fund trades at a thumping 12% discount, at 88 cents on the dollar, and sports a distribution yield of 5.8%.

The second, First Trust Mortgage Income
FMY, -0.93%
, invests in mortgage-backed bonds. With the improvement in the housing market, the default risks of such bonds should be diminishing. Most are rated investment grade. The fund trades at a 12% discount, or under 88 cents on the dollar, and sports a hefty distribution yield of 6.6%.

The next three are municipal funds. Many muni bonds have tumbled amid the panic over Detroit, Puerto Rico and so on, but Gondor notes that underlying fundamentals for many municipalities are actually improving. Gondor highlights Nuveen Dividend Advantage Municipal Income
NVG, +0.62%
, with a tax-free distribution yield of 5.2%, Nuveen Dividend Advantage
NZF, +1.00%
, with a tax-free yield of 5.5%, and Dreyfus Municipal Bond Infrastructure
DMB, +0.31%
, with a distribution yield of 7.3%. All three trade at around 89 cents on the dollar.

There are plenty of other discounts among closed-end funds. I’d give a shout-out to two others I’ve mentioned before: Western Asset/Claymore Inflation-Linked Securities & Income
WIA, -0.52%
and Inflation-Linked Opportunities
WIW, -0.26%
. Both own inflation-protected Treasury bonds and now trade at thumping 15% discounts to net assets, or around 85 cents on the dollar. Bill Gates is a big investor in both, and Gondor says both funds, which are run by a division of fund company Legg Mason, are well-run. Both offer managed annual distributions equal to about 3.4% of the fund’s value.

Inflation-protected bonds, when bought at a reasonable price, can be an excellent investment for many investors, especially those at or near retirement. They are backed by the U.S. government, so you will get your principal back, and they offer protection against rising prices as well.

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